Recovering costs from institutional funders is an increasingly difficult problem for international NGOs. Steve Harper of haysmacintyre lays out a framework to help consider the issue, in advance of Civil Society Media's NGO Insight conference.
Recent years have seen many charities, particularly those operating internationally, place an increasingly significant reliance on institutional funding. In many cases, this has resulted in charities dealing with the dual challenge of a higher proportion of restricted funding and potentially onerous reporting requirements and conditions compared with unrestricted donations. In some instances, the practice adopted has been to pursue institutional funding without fully considering the consequences or administrative requirements resulting from the funding. Some international charities had historically been able to rely on Department for International Development Programme Partnership Agreements to fund a significant proportion of overhead costs, an approach which is no longer possible following the withdrawal of that funding in late 2016.
The challenges faced and typical solutions
Where organisations are inexperienced in this dealing with such challenges, the approach adopted is often project-by-project with little or no visibility of how a project may be subsidised. On the other hand, the best in class are able to measure and track the full costs of a project and report accurately on those costs. Such organisations are often those that have a significant proportion of restricted income, resulting in them needing to place significant focus on recovering costs compared with those organisations that have been able to subsidise institutional funding via their unrestricted funding.
The approaches taken by funders in the area of indirect cost recovery differ significantly, from those funders (such as USAID) that potentially permit full cost recovery to organisations such as the EC, which typically permits only a set percentage recovery. For many organisations, the set percentage approach is at best arbitrary and insufficient to cover the cost of the overheads. However, without fully knowing your cost base, it is impossible to properly assess this and therefore make informed decisions around how resources are best used.
The tendency of many organisations is to try and first reduce costs, or raise voluntary income to cover the gap. In difficult financial times this may not be effective, and may not be the best use of the resources of the charity or may reduce central overheads to such as level as to inhibit the work or the effective running of the charity. Therefore, the question of recovering overheads is also one that should also be considered.
Effective cost recovery models
Those organisations that deal most effectively with cost recovery have a clear model by which overhead recovery is assessed before funding applications are submitted. Core to an effective model is ensuring that the organisation understands the real cost of the project. This enables an organisation to recognise the impact that receiving funding without full overhead recovery can have on reserves in a structured way, and therefore allow for informed decisions to be made as to whether to accept donor funding. Where the organisation is not recovering full overheads, this can help to ensure that this is a conscious decision which is in line with the strategy of the organisation.
The most effective models will allow the organisation to assess not only the costs of the project, but also some of the financial risks. For example, if a project is taking place in a country in which the organisation does not have an established office or significant experience of projects, it is likely this will require a greater level of support from the head office or regional functions and overhead recovery should be priced accordingly.
The importance of knowing donor requirements
It is important to understand that each donor is different, and has different needs and reporting requirements. In some cases, it can be appropriate to include the cost of addressing these reporting requirements within the planned overhead recovery. Again, this is an area where risk should be considered. For example, if the organisation has not previously worked with the donor this may lead to a greater level of risk being attached to the funding. Where this is the case, at the outset the organisation should consider if it has sufficient systems to produce the donor reporting required and, if not, how it can bridge that gap and what the costs of doing so would be.
More broadly, other key donor terms should also be considered at the outset. For example, does the donor pay in advance or in arrears? If the donor pays in arrears, does the organisation have sufficient working capital to fund the project until the first tranche payment would be due? Would there be a significant impact if payment were delayed? It is also important to understand what the donor considers to be indirect costs. Many donors would consider country office or regional office staff to be indirect costs, and therefore these costs should be considered as part of the wider question of cost recovery. However, some donors will permit certain country office and regional office costs to be charged as direct costs. Understanding this at the application stage helps to ensure that the costs are reflected in budgets submitted to the donors.
Linking cost recovery to decision-making
Once a model has been developed, it is important to consider the process by which decisions will be taken. Whilst this is necessarily a financial process, overhead recovery should become a process which is embedded in the wider organisation. Safeguards are needed, however the process should not become one which is too rigid – in some instances, an organisation may choose to take on a high impact project which will recover overheads at a lower rate than the organisation would typically require. The essential point is that this is an informed decision to subsidise the project from unrestricted funds and that it has been assessed as affordable in the context of the other projects and applications that the organisation has.
The approach of assessing overhead recovery at the application stage, and project-by-project, should also feed into the overall financial management of the organisation. Where there is significant institutional funding, a helpful KPI to measure is the recovery of overheads from institutional funding. Some organisations will use a multi-year average to allow for short term timing differences. The funding of overheads as a whole should also be understood – i.e. how are overheads funded, and how long does the organisation have guaranteed funding for those overheads? Once the cost base is fully understood, this facilitates periodic review to help ensure that the cost base itself remains appropriate.
Steve Harper is a senior audit manager at haysmacintyre.
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